Building Efficient Long-Term Capital Structures: Sources of external financing

Building Efficient Long-Term Capital Structures: Sources of external financing

Introduction

Building long term capital structures is highly dependent on the financing option that a firm chooses. The growth of the company in terms of size and finance depends on the option that it chooses and the path that it takes. The capital structure of a company can be defined as the sum of the proceeds of their contributions and those acquired through long-term debt and the financial structure applicable to all debts, both current and non-current coupled to domestic assets or liabilities. The acquisition of funding sources, along with the type of assets held determines the varying degrees of solvency and financial stability of the economic entity. The relative magnitude of each of these components is also important in assessing financial position at any given time. Solvency indicators reflect the company's ability to meet the obligations represented in fixed charges for interest and other financial expenses, due to contractual obligations in the short and long term and timely repayment of the amount owed. This means that the proportion of debt and the amount of fixed costs that flow from the company are indicators of the likelihood of company bankruptcy and insolvency risk, as assumed by investors.

Companies borrow for many reasons. The main is that debt can be cheaper than equity financing because, as a rule, investors demand a higher return and that cost of financing should be incorporated within that remuneration. In other words, the yield paid to creditors is fixed when it comes to equity financing however, it is variable in the case of partners or shareholders. Another reason is the deductibility of debt interest, which can produce, through lower tax paid, an important generation of internal resources to finance future operations, provided that the lowering of tax is caused by the deduction of interest charges (Pietro, 2010, 88).

Sources of funds

Businesses need to grow and function of financial resources. These resources are defined sources of funding, which may be internal and external. The internal financing options include equity and:

Contributions made by the members in the process of formation and duration of the activity

Legal reserves, set aside as the law requires and extraordinary requirements set aside by the company

Reinvestment of profits forgone by the entrepreneur or not distributed to shareholders



The capital has the following features (Rodrik, 2006, 253):

A company risks capital because the company uses it to cover any losses and in case of failure is used to cover any debts

Does not expire because the company remains bound throughout the duration

Does not entail an obligation in remuneration since the company does not owe anything to the shareholders in return for their investment

External financing (debt capital) are capital borrowed by third parties. Their duration are:

Short-term loans (not last more than 1 year)

Medium term (1 to 5 years)

Long-term loans (over 5 years)

The share of credit has the following features:

It is bound for life because the lender sets a deadline by which ...